What’s better than a model train set? How about a real train set that makes a lot of money? That’s the trend in railroad stocks as of late, and parsing some earnings reports tells us that not only are railroads a good place for your investment dollars, but industrials in general might be on the upswing.
Warren Buffett might have said it best when Berkshire Hathaway (NYSE:BRK.A, BRK.B) purchased Burlington Northern in 2009, calling railroads the best-positioned raw material and finished goods haulers. The infrastructure exists and doesn’t need government to tend to it. The sound of a train whistle is the sound of money in the bank.
So it’s no surprise that CSX Corporation (NYSE:CSX) reported a 24% increase in earnings over last year on a 10% increase in revenue. Because people that need massive amounts of goods to be hauled really don’t have any other choice besides rail, they can be slapped with fuel charges to offset increasing fuel prices. The company carries $7.6 billion in debt, but cash from operations was $3.4 billion (up from $3.2 billion). It’s a very profitable business model, with gross margins of 38% and operating margins of 28.5%. You might not expect that from such a capital-intensive company.
Kansas City Southern (NYSE:KSU) is another railroad enjoying good times. Earnings per share were up 75% over the same quarter last year on an 11% increase in revenue. Again, we see great profitability metrics, with gross margins of 58% and operating margins of 28.4%. Meanwhile, Norfolk Southern (NYSE:NSC) also blasted across the rails, with net income up 33% on a 17% sales increase. This kind of mid-teens revenue growth has been happening for five consecutive quarters.
This is really great news for railroads. Analysts see about an average of 15% annualized growth for these companies over the next five years. CSX trades at 10 times earnings, Norfolk trades at 12, and Kansas City trades at 20 times estimates. Two of these three are thus apparently undervalued.
The strong move in this sector also suggests the economy might be in the early stages of recovery. If railroads are hauling goods, then companies are producing those goods. These kinds of industrial-based companies also are known as cyclicals, as they are tied to the economic cycle. That means you also might want to consider chemical stocks like DuPont (NYSE:DD), and coal stocks such as Alpha Natural Resources (NYSE:ANR). You’ll also find I am very enthusiastic about the mega-diversified industrial legend General Electric (NYSE:GE). I’m also a fan of Deere & Co. (NYSE:DE) in this environment.
Now is the time to start paying close attention to earnings reports from all of these companies, and other cyclicals. But also be on the lookout to see if things suddenly fade, suggesting a (unlikely) double-dip recession. You also should watch the monthly Purchasing Manager’s Index number. A value over 50 points means manufacturing is expanding, and that has been the trend for the past few months.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at SeekingAlpha.com. He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.